If there was any lingering doubt Eddie Lampert wasn’t trying to liquidate Sears Holdings (SHLD), Tuesday’s announcement wiped away yet another part of that doubt. The struggling retailer set itself up to shed another 25 of its stores by using that property as collateral for a loan worth up to $400 million.
… who is also ultimately the lender.
While the arrangement is not illegal, it is unusual. It’s so unusual, in fact, that it’s not clear what (if anything) Lampert might have up his sleeve.
Knowing that Eddie Lampert hasn’t been shy about shedding the best pieces of SHLD, though (and chanting “transformation” the entire time he’s done it), it wouldn’t be wrong to entertain the notion that this is just another step down the road to a complete breakup of Sears.
Details of the Deal
Still cash-strapped and heading into the busy holiday shopping season, Sears is tapping JPP LLC and JPP II LLC — both affiliated with Eddie Lampert’s hedge fund ESL Investments — for a short-term loan of $400 million. The proceeds have been earmarked by SHLD for nothing other than general purposes.
The basic terms of the loan are reasonable; the annual interest rate at stake is only 5%, plus a 0.5% initiation fee, with 25 stores (to be picked by the lender) serving as collateral.
Given the short duration of the loan, the interest payments would only earn ESL Investments and its two affiliates a total of about $10 million. It’s such a tepid ROI for the hedge fund manager and his related organizations, in fact, one has to wonder why he’s even bothering.
To be clear, without the loan, Sears might not be able to function through the end of the year. In that light, Sears stock owners correctly see the loan is a “must-have” for the company. What still hasn’t been made clear to those who own or follow Sears stock, however, is why such valuable collateral is being put on the line by a company that could very likely default on the loan.
SHLD Is a Bad Risk
To be fair, SHLD hasn’t failed to pay on its debts yet. Its credit rating now stands at a pitiful CC with Moody’s though, which means a “default of some kind appears probable.”
The numbers and trend don’t offer any budding hope either. Sears Holdings lost $570 million last quarter. And, SHLD has lost money in nine straight quarters, with most of those losses being bigger than the last. Total sales have fallen for 30 consecutive quarters.
So again the question is raised: Why would Eddie Lampert direct his struggling company to borrow money from another of his organizations and use 25 stores as collateral? If keeping Sears Holdings alive is his only goal, he could make a no-collateral loan. After all, at the end of the day it’s all his money and his decision.
The most plausible answer is, this is the easiest way to facilitate the transfer and eventual sale of 25 more stores, sustaining the liquidation effort that began a couple of years ago when Lampert shed the Sears Hometown (SHOS) and Orchard Hardware divisions.
The Sum of the Parts…
It’s difficult for Sears stock holders to call this a conflict of interest, as Eddie Lampert is the effective owner of the borrower and the lender in an arrangement that on the surface looks like it could be no worse than a wash.
How so? If Sears Holdings can’t repay the loan and ends up sacrificing 25 stores (that the company was likely looking to sell anyway), JPP and JPP II win valuable real estate, and the retailer loses valuable assets. Yet, the stores technically still would have access to the funding and whatever return it provides in the meantime.
If instead Sears Holdings is able to repay the loan with the required interest, Eddie Lampert’s affiliates pocket $10 million in interest income, and Lampert still effectively owns all the Sears stores through his stake in SHLD. On a net basis, the cash and/or consideration is either under one Lampert umbrella or another.
There’s more to the story, however.
Dividing a $400 million loan by 25 stores would imply each unit is worth $16 million. In reality, Sears Holdings has been able to sell stores at a much better price, letting them go anywhere from $20 million to $50 million each. Even at the low end of that range, JPP and JPP II would be better off if Sears Holdings defaulted.
And, knowing Eddie Lampert has been hosting a yard sale for quite a while, it seems likely a default is somehow the actual goal here. It certainly would accelerate the company’s obvious breakup.
This very well could be a sign that Lampert has finally realized there’s little point left in trying to save the drowning retailer and is now moving more quickly to rid himself of his cash-burning asset.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.